I abandoned the stricken supermarket sector several years ago and although I've never regretted that decision I did cast the odd backward glance at J Sainsbury(LSE: SBRY).
Ups and downs
I always felt it rather unfairly treated by investors who were sniffy even when the supermarket was posting 36 consecutive quarters of sales growth under former boss Justin King. The moment that record fell, they dropped their shopping baskets and made a dash for the exits.
Yet Sainsbury's has largely held its own in terms of market share at least, despite incursions from Aldi and Lidl, and even if profitability did slip. While not as upmarket as Waitrose, it was upmarket enough to retain the affections of better-off shoppers, while Tesco(LSE: TSCO) and WM Morrison got sucked into a downmarket brawl with the German under-cutters.
Food, inglorious food
This week saw Sainsbury's reporting it grew again in Q4, with like-for-like retail sales growth (excluding fuel) for the first quarter in over two years. That said, it was a damned nice thing at just 0.1%, although total sales also rose 1.2%. Fastest growth was in non-food items such as clothing, banking and travel. Food clearly tastes better online where grocery sales rose nearly 14% and orders nearly 19%. That partly explains its pursuit of Argos owner Home Retail Group, which would generate around £4bn a year of non-food sales. The bidding deadline is due to expire at 5pm today.
This transaction is a distraction I could do without and I remain unconvinced of the long-term case for Argos. Sainsbury's has demonstrated its durability and doesn't look overpriced at 10.66 times earnings. But wafer thin margins of 1.3% and patchy earnings per share (EPS) growth forecasts still make me wary.
Tesco has also been on an upward trajectory, rising 7% over the last month and 33% over three months. Better-than-expected results in January helped, but like Sainsbury's, the UK's largest grocer is seeking the higher growth and margins beyond its core food business. It's looking to expand in the mobile market with plans to buy O2's half of its Tesco Mobile joint venture. However, this is also a competitive area, with Sky looking to enter the mobile market later this year.
The move is quite a U-turn for chief Dave Lewis who was planning to sell Tesco Mobile last year to help repair the company's balance sheet. But let's not quibble, he's done well since his appointment, taking firm action to stamp out bad practices and drop under-performing operations. Debt levels remain high, despite Lewis offloading the Korean business for several billion, plus there are lease liabilities on top. He's helped by the fact that Tesco no longer plans to sink large sums into new new store building.
Sainsbury's and Tesco are on the mend but still face major challenges both from the German low-cost rivals and Amazon. I'm tempted by this sector for the first time in years, but suspect the supermarkets will struggle to build on recent share price growth, especially if the global economy stumbles again.
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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.